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December 29, 2009

Paul Samuelson and Tax Policy in the Kennedy Administration

Joseph J. Thorndike

When Paul Samuelson died last month, there was much discussion of his textbook and Nobel Prize. But obituaries also noted his stint as an economic adviser to President Kennedy. As a member of the Kennedy brain trust, Samuelson played a vital role in shaping the landmark tax cut passed in 1964.

Samuelson's position in the Kennedy administration was never official, but he was influential. Shortly after the 1960 election, he declined an appointment as chair of the Council of Economic Advisers, choosing instead to remain at the Massachusetts Institute of Technology, where he had been teaching economics since 1940.

Samuelson did agree, however, to chair a special economic advisory panel for the president-elect. In the weeks leading up to Kennedy's inauguration, that panel produced a report that proved -- more than most such documents -- to be highly significant.

Samuelson as Adviser

Samuelson served as both a private and a public adviser to Kennedy. In late 1958 he joined a committee of prominent economists advising the young candidate. The group included such luminaries as John Kenneth Galbraith and Seymour Harris of Harvard, as well as James Tobin of Yale. Those advisers offered ideas, but also an implicit endorsement as Kennedy struggled against his reputation as a lightweight.1

After the election, Samuelson famously tutored the president-elect while sitting on a rock in the Kennedy compound at Hyannis Port. He instructed JFK on the elements of economic analysis and warned that storm clouds were gathering on the nation's economic horizon.2 Unemployment was high and rising, approaching 7 percent as Inauguration Day grew near.3 Economic output was consequently subpar, leaving the nation with considerable economic slack. According to some estimates, the nation was using only 80 percent of its economic capacity.4

Samuelson warned Kennedy that the nation might already be headed into a recession. The diagnosis was unwelcome, as was the prescription. Samuelson, like most of the nation's leading economists, had embraced a version of postwar Keynesianism that emphasized the stabilizing role of fiscal policy. Faced with a looming slowdown, Samuelson and his colleagues suggested a program of expansionary spending.

Kennedy's pre-presidential economic convictions were, as Herbert Stein later observed, "lightly held."5 But he harbored conventional notions of sound finance -- including a penchant for balanced budgets -- that were not easily reconciled with Keynesian solutions to economic stagnation. JFK also understood the political hurdles facing any program of expansionary fiscal policy. While most economists had embraced the Keynesian revolution, many politicians in both parties had not.

Bringing Keynes to Washington

Nonetheless, Kennedy seemed to grasp the urgency of Samuelson's prescription. Slowly he began reshaping the political landscape surrounding economic policy. And once again he asked Samuelson to play a vital -- and this time more public -- role.

In late 1960 Kennedy recruited Samuelson to head a special study committee on economic policy. That "antirecession task force," as it was soon dubbed by the press, was designed to pave the way for expansionary fiscal policy. At the same time, it was intended to give the new president distance from Democratic dogma that critics considered dangerous.

Many business leaders, for instance, were deeply suspicious of the incoming administration. Indeed, they were wary of Democrats in general, whom they suspected of being soft on inflation. Manufacturers were willing to consider some modest expansionary initiatives. But the financial community remained steadfastly opposed to anything that might threaten the stability of the dollar.6

Business critics had reason to be suspicious. In its 1960 platform, the Democratic Party endorsed a vigorous program designed to boost economic growth, calling for an end to the "high-interest, tight-money policy" of the Eisenhower years. The platform stated:

This policy has failed in its stated purpose -- to keep prices down. It has given us two recessions within five years, bankrupted many of our farmers, produced a record number of business failures, and added billions of dollars in unnecessary higher interest charges to Government budgets and the cost of living. . . . A new Democratic Administration will reject this philosophy of economic slowdown. We are committed to maximum employment, at decent wages and with fair profits, in a far more productive, expanding economy.7

Critics warned that such a program was a recipe for runaway inflation, especially when coupled with Democratic spending plans that also were ambitious. Anticipating those attacks, however, the campaign platform stressed the importance of price stability. But few were fooled. Democrats were clearly more willing to risk a bout of inflation than Republican leaders had been during the 1950s.

The Kennedy Keynesians

As Kennedy neared his inauguration, he sought to reassure critics by moderating his stance on economic issues, including the ostensible trade-off between growth and inflation. In particular, he sought to create some distance between his administration and some of the Democratic Party's more vigorous champions of full employment.

Samuelson's study group played a vital role in the transformation of the Kennedy agenda. When the panel released its report, it was immediately hailed as a moderate's manifesto. But Samuelson also used the document to make a strong case for expansionary fiscal policy, at least over the medium and long term.

The antirecession report, released in early January 1961, was entitled "Prospects and Policies for the 1961 American Economy." It began with the same sort of warning that Samuelson had delivered to Kennedy on the beach at Cape Cod. "Economic experts are generally agreed that the nation's economy is now in a 'recession,'" it said. "Prudent economic policy must face the fact that we go into 1961 with business still moving downward."8

Unemployment, already over 6 percent, was probably headed up. Profits were almost certainly going down. While politicians might want to avoid such unpleasant realities, there was no hiding from the facts. "Not even the ostrich can avert the economic facts of life," Samuelson wrote. "He misreads the role of confidence in economic life who thinks that denying the obvious will cure the ailments of a modern economy."

Any recession was painful, the report continued, but this one was especially dangerous, since it had developed in the midst of a more sustained slowdown in economic growth:

In economics, the striking event drives out attention from the less-dramatic but truly more fundamental processes. More fraught with significance for public policy than the recession itself is the vital fact that it has been superimposed upon an economy which, in the last few years, has been sluggish and tired.

Recovery from the recession of 1958 had been anemic. The nation had never returned to anything like high employment, with more than 5 percent of workers continually idle: "A most disappointing performance in comparison with earlier post-war recoveries and desirable social goals." Such sluggishness threatened to become permanent, unless Congress did something to foster not just short-term recovery, but long-term growth.

Expansionary fiscal policy was the only viable solution, Samuelson explained, because monetary policy was constrained by a chronic balance of payments deficit. Policymakers should move quickly to increase and accelerate spending programs that were "desirable for their own sake." They should also boost unemployment benefits, foster residential housing construction through various incentives, and pursue a variety of other socially desirable spending programs, including urban renewal and natural resource development.

Tax Cuts

Samuelson warned that additional spending might not be enough to win the battle against recession -- and keep it won. In that case, the nation must turn to a second line of economic defense: tax cuts. Samuelson understood that expansionary tax cuts were controversial, not least because they seemed to flout the hoary traditions of fiscal conservatism. If deficits were a natural byproduct of recession, then making them even bigger by slashing tax rates seemed rash -- at least to many policymakers.

But Samuelson directly challenged such atavistic orthodoxies. Deficits that arose from stimulatory fiscal policy were not just tolerable, but desirable. They had to be distinguished, he insisted, from shortfalls brought on by excessive spending:

The deficits that come automatically from recession or which are a necessary part of a determined effort to restore the economic system to health are quite different phenomena [from deficits driven by out-of-control spending]. They are signs that our automatic built-in stabilizers are working, and that we no longer will run the risk of going into one of the great depressions that characterized our economic history before the war.

In the face of persistently high unemployment, policymakers should enact temporary tax cuts, Samuelson advised. "Congress could legislate, for example, a cut of three or four percentage points in the tax rate applicable to every income class, to take effect immediately under our withholding system, in March or April and to continue until the end of the year," he wrote. Also, the president might be granted authority to extend those tax cuts for six months or a year after their initial expiration.

Tax cuts must be temporary, however, if only to preserve the nation's long-term fiscal health. "With the continued international uncertainty and with new public programs coming up in the years ahead," Samuelson wrote, "sound finance may require a maintenance of our present tax structure, and any weakening of it in order to fight a recession might be tragic."

The report left room for more permanent reductions in personal income tax rates, which most economists considered excessively high. But such cuts should be part of more fundamental tax reform, including efforts to broaden the tax base by reducing preferences. That sort of tax program should be advanced on its own merits, Samuelson wrote, not as part of an antirecession package.

A Moderate Manifesto

Samuelson's report was ambitious, but it was hardly radical. By stressing a few relatively moderate spending increases -- and the acceleration of existing spending programs -- it sought to draft expansionary fiscal policy out of existing spending priorities. It also stressed that major new spending programs should await further analysis of the economic situation.

"It is just as important to know what not to do as to know what to do," the report noted. "What is definitely not called for in the present situation is a massive program of hastily devised public works whose primary purpose is merely that of making jobs and getting money pumped into the economy." The New Deal was replete with such spending, but 1961 was not 1933. There was no need to "push the panic button and resort to inefficient spending devices," the report said.

The Samuelson report received a generally warm welcome, especially from the press. Most observers seemed to understand that it was carefully designed to put a moderate face on Democratic policies, and they valued the effort. Still, not everyone was convinced that it would succeed. "The recommendations, of course, are those of a small group of men operating independently of the many political and bureaucratic factors that go into the formation of national policy," The New York Times observed. "That gives the recommendations the virtue of being relatively 'pure,' but it also makes them subject to some revision in the government wringer."9

Indeed, the wringer did its job, delaying and transforming the Samuelson recommendations. The tax cuts that got their first public airing in the Samuelson report would not see the light of day for years. But the report was still important, because it represented one of the Kennedy administration's first -- and most comprehensive -- statements of economic priorities.

4 Cathie Jo Martin, "American Business and the Taxing State: Alliances for Growth in the Postwar Period," in Funding the Modern American State, 1941-1995: The Rise and Fall of the Era of Easy Finance, edited by W. Elliot Brownlee, Washington and New York: Woodrow Wilson Center Press and Cambridge University Press, 1996, p. 363.

5 Stein, supra note 1, at 374.

6 On business and economic policy in the early 1960s, see Martin, supra note 4, at 365-368.